All About Exchange Traded Funds (ETFs)

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(NC)-Research shows that Canadians pay among the highest fees in the world to invest in mutual funds, 2.6% on average for a Canadian balanced fund, according to an Ipsos-Reid poll. However, index funds and Exchange Traded Funds (ETFs), are both low-cost investment options that have been gaining in popularity in recent years, providing Canadians with a cheaper alternative for getting into the market. The question many investors struggle with is which investment option provides more value.

The answer boils down to your investor personality.

Index funds are mutual funds that hold the same securities listed in stock indexes. ETFs are essentially the same as index funds however they are traded on the stock exchange.

The main difference between index funds and ETFs is cost, followed by how the funds are sold and distributed. While investors are attracted to ETF's low management expense ratio (MER) and their stock-like features, there are other fees and buying methods to be considered in order to determine if index funds or ETFs provide more value for money.

• ETFs are bought through discount brokers which allow you to purchase investments through professionals who buy and sell the items you want them to. While you could potentially pay as low as $9.95 per trade to buy and sell each ETF, it is generally reserved for the most active traders or preferred clients with high balances. The everyday investor pays roughly $27 per transaction for ETFs, based on the average of the posted commissions at the major discount brokerage firms. Index funds are typically purchased through banks on a no load basis. You do not need to hold an account with a brokerage firm to buy index funds.

• ETFs assume that the investor takes a more active role in the management of their investments. This means that the portfolio will need to be rebalanced on a regular basis. Rebalancing an ETF portfolio once a year can change the cost structure significantly. You can buy individual index funds or balanced funds that typically include rebalancing on a quarterly basis, which basically allow you to "set-it-and-forget-it".

• Commissions apply to each buy and sell of ETFs. This means that it will cost more to practice dollar cost averaging (buying more units at a lower price and fewer units at a higher price over time). Some index funds, like ING Direct's Streetwise Funds include the option for regular, automatic deposits, at no charge.

• Brokerage accounts include account administration fees associated with RRSP accounts, which can add another $100 per year to the costs. Most bank offered index funds will have low, or no administration fees.

Many index funds, such as ING Direct's Streetwise Funds may have slightly higher MERs (about 1% on average) as compared to ETFs (0.5% on average), however, there are often no additional costs to buy and sell or rebalance, resulting in significant savings over the long term.

In order to determine which index strategy is right for you, you first need to determine what type of investor you are. If you are an active investor who keeps tabs on the ups and downs of the markets and trade frequently through your online brokerage account, then ETFs may make more sense for you. If you are more passive about your investments, want automatic rebalancing, and to take advantage of built-in dollar cost averaging, index funds may provide you with the best value for your money.